Spending on health care now constitutes a signicant fraction of total expenditur

Question

Spending on health care now constitutes a signicant fraction of total expenditure. Understanding the efcacy of this spending is therefore relatively important. When it comes to contagious diseases, there are generally two strategies that can be adopted. The rst involves prevention, which includes vaccinations to lower or eliminate the risk of contracting a disease. The second involves treatment of those unfortunate enough to get sick, treatment typically requires some form of a drug. Since pharmaceutical companies can produce both vaccines and drugs, we would like to understand the incentives they have to develop each type of medicine. To explore this question, consider a population of 100 consumers, 90 of whom have a low disease risk, say 10%. The remaining ten have a high risk – to make things simple, assume they are certain to contract the disease. In addition, suppose the disease generates personal harm equal to the loss of $100 for each individual when they are infected. Suppose also that pharmaceuticals of either form (vaccines or drugs) are costless to produce (once R & D has occurred) and are perfectly effective.

Question 2. What price would a prot maximizing monopolist charge for a vaccine? What are the monopoly prots on the vaccine? What is the efcient outcome (i.e. SMB = SMC)? What is the welfare under the monopoly and at the efcient allocation?[5 points]

Explanation / Answer

Vaccines will be taken by the consumers with low disease risk. The low disease risk is 10%. The loss for person infected with disease is $100. Therefore, expected loss from disease infection to a low disease risk person is 0.1 * $100 = $10. The profit maximising charge for vaccine would be $10.

Monopoly profits= Price*quantity = $10* 90 = $900

Efficient outcome would be a price of zero( because the marginal cost is zero.)

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